On December 22, 2006, the Securities and Exchange Commission unexpectedly amended its recently-adopted rules for disclosure of executive and director compensation in proxy statements. As amended, the proxy statement will disclose equity awards based on compensation cost determined in accordance with Financial Accounting Standards Board Statement of Financial Accounting Standards No. 123 (revised 2004) (FAS 123R). The amendments are now effective for companies that are subject to the revised disclosure rules.

Recognized Compensation Cost Will Be Disclosed

Prior to this change, the amounts disclosed for equity awards in the Summary Compensation Table and the Director Compensation Table would have been the aggregate grant date fair value computed in accordance with FAS 123R. The only awards required to be disclosed in those tables were those granted in the applicable year. The new disclosures will track the compensation cost recognized for financial statement purposes with respect to not only awards made in the applicable year, but also the cost of awards made in earlier years that is being recognized in the applicable year. However, the amount to be reported in the table must exclude the amount estimated for forfeitures related to service-based vesting conditions.

For example, assume a company has granted an executive an option award in each of the preceding three years. Each award vests equally over a four-year period. The FAS 123R fair value of the 2006 award on its grant date was $750,000. The adjusted FAS 123R fair value amounts (excluding forfeitures) are as follows: 2004 grant - $550,000; 2005 grant - $660,000; and 2006 grant - $825,000. The amount shown in the Option Awards column of the Summary Compensation Table for 2006 before and after this change would be:

(see http://www.bakerdaniels.com/newsandevents/newsletters/article.aspx?publication=2325)

Thus, while the amount reported for the 2006 award will decrease, this will be offset by picking up amounts attributed to awards made in earlier years that vested in 2006.

The FAS 123R amounts disclosable before this change will still be reported. A new column has been added to the Grants of Plan-Based Awards Table and a footnote will need to be added to the Director Compensation Table that will report the grant date fair value computed in accordance with FAS 123R (including estimated forfeitures) of each equity award (on an award-by-award basis) granted in that year.

Other Changes

  • Because the change will affect the total compensation amount used to determine who the “named executive officers” are, companies may have to reconsider the composition of that group.
  • An equity award granted to a person who is eligible to retire will be disclosed in the Summary Compensation Table at its grant date fair value because under FAS 123R that full amount is recognized in the financial statements in the year of grant.
  • The FAS 123R expense of equity awards subject to performance-based vesting conditions will be included in the Summary Compensation Table when it is probable that the performance condition will be achieved.
  • Previously-recognized compensation amounts could be reversed in a subsequent year:

- The cost of forfeited awards that were previously disclosed will now be deducted for the year in which the forfeiture occurred, and any   forfeitures must be disclosed in a footnote to the table.

- The probability of earning a performance-based award that is downgraded would reduce or reverse the prior amounts disclosed.

  • If a named executive officer or director elects to forego any cash salary or bonus in favor of a non-cash form of compensation, the foregone compensation must still be reported in the salary or bonus column of the Summary Compensation Table or the fees earned or paid column of the Director Compensation Table. In addition, footnote disclosure of the non-cash compensation is required and, in the case of named executive officers, must also refer to the Grants of Plan-Based Awards Table where the non-cash award is reported.
  • Stock-based awards that are accounted for as “liabilities” (such as cash-settled stock appreciation rights) will reflect increases and decreases in the value of the company’s stock on a mark-to-market basis from year to year. Decreases in the stock price may decrease the compensation disclosed.
  • Whether or not a company has elected to use the “modified prospective transition method” of FAS 123R for financial statement purposes, the disclosures required by the SEC rules must be calculated in accordance with that method.

These last minute changes complicate the task facing companies which are subject to the new compensation disclosure rules. Companies which already have the new tables formatted and information gathered will have to revise them and possibly increase the accounting resources dedicated to the process. Companies that haven’t progressed that far are facing a larger task with limited time available to complete it.